Hey there I'm James and in this video I'll explain  how operating profit margin works with an example
Hey there I'm James and in this video I'll explain  how operating profit margin works with an example

operating profit margin or operating margin  is operating profit divided by revenue  
operating profit margin or operating margin  is operating profit divided by revenue  

it's another profitability ratio similar to gross  profit margin which we covered in my last video
it's another profitability ratio similar to gross  profit margin which we covered in my last video

this one measures a business's ability to generate  operating profit from each unit of revenue earned
this one measures a business's ability to generate  operating profit from each unit of revenue earned

if we multiply it by 100 then we  can express it as a percentage  
if we multiply it by 100 then we  can express it as a percentage  

so how does operating profit margin work?  we'll begin with profit
so how does operating profit margin work?  we'll begin with profit

profit is the financial gain generated in a business when its revenues are bigger than its expenses
profit is the financial gain generated in a business when its revenues are bigger than its expenses

in a basic income statement like this one we can find it sitting at the bottom
in a basic income statement like this one we can find it sitting at the bottom

okay but what about operating profit?
okay but what about operating profit?

this basic income statement only has one line for expenses if we want to look at it in more detail  
this basic income statement only has one line for expenses if we want to look at it in more detail  

then we can expand it out first we take away the direct cost of sales or cost of goods sold
then we can expand it out first we take away the direct cost of sales or cost of goods sold

these are the variable expenses that are directly  involved in producing products
these are the variable expenses that are directly  involved in producing products

that gets us to gross profit the big profit and below that we subtract all of the businesses operating expenses
that gets us to gross profit the big profit and below that we subtract all of the businesses operating expenses

these are the ongoing day-to-day costs involved  in running a business things like research and development
these are the ongoing day-to-day costs involved  in running a business things like research and development

selling, general, admin expenses, depreciation and amortization
selling, general, admin expenses, depreciation and amortization

this is where operating profit comes in it's the financial gain left in the business after deducting all
this is where operating profit comes in it's the financial gain left in the business after deducting all

the direct cost of sales and operating expenses  below that we also remove interest and tax  
the direct cost of sales and operating expenses  below that we also remove interest and tax  

which is why operating profit is sometimes called  earnings before interest and tax or 'EBIT' for short  
which is why operating profit is sometimes called  earnings before interest and tax or 'EBIT' for short  

but we'll go with operating profit on the bottom line we're left with net profit
but we'll go with operating profit on the bottom line we're left with net profit

which we'll get on to next time so click subscribe if you'd like to watch that
which we'll get on to next time so click subscribe if you'd like to watch that

you can find all of these videos in my financial ratios playlist which I'll link to in the description
you can find all of these videos in my financial ratios playlist which I'll link to in the description

so one more time what is operating profit margin? operating profit margin is a business's operating profit 
so one more time what is operating profit margin? operating profit margin is a business's operating profit 

divided by its revenue and by the way you can find this formula on my
divided by its revenue and by the way you can find this formula on my

profitability ratios cheat sheet which you can find in the description as well
profitability ratios cheat sheet which you can find in the description as well

it measures how much operating profit they're able to generate for each dollar of revenue earned
it measures how much operating profit they're able to generate for each dollar of revenue earned

it only accounts for the businesses direct cost of sales and operating expenses
it only accounts for the businesses direct cost of sales and operating expenses

it ignores the interest and tax expenses which we can see further down the income statement
it ignores the interest and tax expenses which we can see further down the income statement

great so let's do an example  here's the income statement for a business called 'MAD'
great so let's do an example  here's the income statement for a business called 'MAD'

a tech company that makes semiconductor products it summarizes the revenue they earned
a tech company that makes semiconductor products it summarizes the revenue they earned

and the expenses they incurred over a one year period but what is MAD's operating profit margin?
and the expenses they incurred over a one year period but what is MAD's operating profit margin?

well we can see that they earned revenue of 1 billion dollars and after subtracting their cost of sales
well we can see that they earned revenue of 1 billion dollars and after subtracting their cost of sales

and operating expenses they were left with an operating profit of 150 million dollars
and operating expenses they were left with an operating profit of 150 million dollars

so their operating profit margin is 150 million dollars in operating profit divided by 1 billion dollars in revenue
so their operating profit margin is 150 million dollars in operating profit divided by 1 billion dollars in revenue

that's 15 cents of operating profit generated for each dollar earned or 15% when we times it by 100
that's 15 cents of operating profit generated for each dollar earned or 15% when we times it by 100

very nice but whilst it's helpful for us to know this number
very nice but whilst it's helpful for us to know this number

operating profit margin becomes more valuable when we make comparisons for example we can compare it year on year
operating profit margin becomes more valuable when we make comparisons for example we can compare it year on year

here are MAD's income statements for the past two years in the current year they generated 150 million dollars
here are MAD's income statements for the past two years in the current year they generated 150 million dollars

in operating profit with an operating margin of 15%
in operating profit with an operating margin of 15%

but in the previous year they only managed  an operating profit of 70 million dollars
but in the previous year they only managed  an operating profit of 70 million dollars

when we divide that by their revenue of  700 million dollars we can see that their
when we divide that by their revenue of  700 million dollars we can see that their

operating profit margin was 10% so overall that's a  5% increase in operating profit margin year on year
operating profit margin was 10% so overall that's a  5% increase in operating profit margin year on year

which is not bad at all we can also compare  operating profit margin against similar businesses
which is not bad at all we can also compare  operating profit margin against similar businesses

this time we've got the current year income  statements for MAD and INLET two competitors
this time we've got the current year income  statements for MAD and INLET two competitors

in the same industry INLET is the market leader in  semiconductor products and they earned a whopping
in the same industry INLET is the market leader in  semiconductor products and they earned a whopping

7.8 billion dollars in revenue and their  operating profit was 2.34 billion dollars
7.8 billion dollars in revenue and their  operating profit was 2.34 billion dollars

2.34 divided by 7.8 is 0.3 or 30 percent so not only is INLET earning more revenue than MAD 
2.34 divided by 7.8 is 0.3 or 30 percent so not only is INLET earning more revenue than MAD 

they're also converting each dollar of that revenue into operating profit more efficiently
they're also converting each dollar of that revenue into operating profit more efficiently

what causes a decrease in operating profit margin? warning i'm going to do a little bit of
what causes a decrease in operating profit margin? warning i'm going to do a little bit of

math here to help explain this operating profit  margin is operating profit divided by revenue
math here to help explain this operating profit  margin is operating profit divided by revenue

we saw earlier that operating profit is the same  as gross profit minus operating expenses
we saw earlier that operating profit is the same  as gross profit minus operating expenses

now if we separate this into two fractions and divide gross profit by revenue then operating profit margin
now if we separate this into two fractions and divide gross profit by revenue then operating profit margin

is equal to gross profit margin minus operating expenses divided by revenue how does this help us?
is equal to gross profit margin minus operating expenses divided by revenue how does this help us?

well it shows us that there are two ways that operating profit margin can decrease either the gross profit margin
well it shows us that there are two ways that operating profit margin can decrease either the gross profit margin

has gone down for all of the reasons that  i mentioned last time in the gross profit margin video
has gone down for all of the reasons that  i mentioned last time in the gross profit margin video

or operating expenses have increased as a  proportion of revenue perhaps they're spending
or operating expenses have increased as a  proportion of revenue perhaps they're spending

more on research and development or administrative  expenses or maybe the business has been selling
more on research and development or administrative  expenses or maybe the business has been selling

their products or services at a discount on the other hand what causes an increase in operating profit margin?
their products or services at a discount on the other hand what causes an increase in operating profit margin?

we've still got the same formula but  the arrows have flipped around gross profit margin
we've still got the same formula but  the arrows have flipped around gross profit margin

could have gone up which would have a knock-on  effect on operating profit margin or the
could have gone up which would have a knock-on  effect on operating profit margin or the

businesses operating expenses have decreased  relative to the revenue it earned it could have  
businesses operating expenses have decreased  relative to the revenue it earned it could have  

hiked the prices on its products or services or it  could have reduced its operating expenses through
hiked the prices on its products or services or it  could have reduced its operating expenses through

better cost management as always a big thanks to all my channel members  
better cost management as always a big thanks to all my channel members  

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stay safe and I'll see you next time!
stay safe and I'll see you next time!